Forget the Fed and BOJ; PBOC holds the monetary cards
The most globally crucial monetary calls for the rest of 2024 will come out of Beijing, not Washington or Tokyo
TOKYO – With all the focus on the US Federal Reserve and Bank of Japan, it’s easy to forget where the most important monetary calls are being made this year: Beijing.
Sure, Fed Chairman Jerome Powell said Wednesday (July 31) that big actions are coming. A September interest rate cut is “on the table,” provided the inflation data supports one. That, and BOJ Governor Kazuo Ueda’s modest 0.15% rate hike hours earlier, is the talk on global markets.
But both narratives, though, are more of the signaling variety than anything that’s going to make or break the world’s No. 1 or No. 3 economy. How People’s Bank of China’s Governor Pan Gongsheng plays his monetary hand in Beijing will likely have far more impact given the intensifying headwinds bearing down on Asia’s biggest economy.
For all their challenges, neither the US nor Japan faces simultaneous mini-crises with property developers, weak household spending and deflationary pressures. Neither confronts youth unemployment at record highs. Neither faces domestic headwinds from municipalities grappling with US$10 trillion-plus of local government financing vehicle (LGFV) debt.
All this explains why the PBOC surprised global markets with an interest rate cut on July 25, when it cut the one-year policy loan rate by 20 basis points to 2.3%, the biggest move since April 2020. That came just days after the PBOC lowered a key short-term rate.
In July, mainland manufacturing activity unexpectedly fell for the first time in nine months. The Caixin manufacturing purchasing managers index slid to 49.8 last month from 51.8 in June. The dip suggests China’s export machine is losing momentum, dimming the economy’s prospects.
“The most prominent issues are still insufficient effective domestic demand and weak market optimism,” says Wang Zhe, economist at Caixin Insight Group.
Yet for all the turmoil in China’s economy, there are signs that the PBOC might be done lowering rates for a while.
The PBOC “moves reflect ongoing deflationary pressure and should modestly support growth,” says Duncan Innes-Ker, analyst at Fitch Ratings. “Nevertheless, we believe the prospects for further rate cuts are limited by the government’s wariness of adding to pressure on the renminbi exchange rate.”
Perhaps more important is that currency traders suddenly seem more interested in bracing for a rising yuan than a falling one.
Hedging trends show that the premium for put options used to bet on a weaker dollar-yuan relative to wagers on a stronger rate are at levels not seen in 13 years.
Nor do measures of expected volatility appear to be spiking as the Fed and BOJ finally make, or move toward, long-awaited rate moves.
Some of the yuan’s stability owes to a now-rallying yen. Its surge in the wake of the BOJ hiking rates the most since 2008 has the yuan trading at two-month highs. Chinese state banks are reinforcing the move and putting the dynamic to good use by selling dollars.
This dovetails with President Xi Jinping’s top-line priority for the yuan. In recent years, Xi’s inner circle worried that a weaker yuan might make it harder for giant property developers to make payments on offshore debt, heightening default risks.
More recently, Xi’s Communist Party has tried to avoid becoming a bigger election issue in the US, where Donald Trump is making another play for the presidency and looking to make trade wars great again.
Perhaps the biggest priority, though, is Xi’s yuan internationalization policy. Since 2016, Team Xi has made steady and significant progress toward supplanting the dollar as the linchpin of the global financial system.
That year, Beijing secured a spot in the International Monetary Fund’s “special drawing-rights” program. It put the yuan into the globe’s most exclusive currency club along with the dollar, euro, yen and the pound.
As Xi’s “yuanization” gambit gains traction, it stands out as one of his top reform successes. In March, the yuan hit a record high of 47% of global payments by value.
In 2023, the yuan topped the yen as the currency with the fourth-largest share in international payments, according to financial messaging service SWIFT. It overtook the dollar as China’s most used cross-border monetary unit, a first.
The strategy would get a major boost if the BOJ can continue hiking rates and the Fed ratchets rates lower.
Both of these dynamics are an open question. The BOJ, for example, confronts a sluggish economy, tepid wage growth and political paralysis in Tokyo.
“The rate hike sits uncomfortably with the poor run of economic data and lack of demand-driven inflation,” says Moody’s Analytics in a note.
Gross domestic product, Moody’s adds, “has been falling for the better part of a year. And consumer price inflation has slowed sooner than expected, despite jumpy headline and core CPI readings.”
What’s more, “the ‘shunto’ spring wage negotiations produced a three-decade record result, but actual pay gains recorded across the economy have been disappointing,” Moody’s notes. Also, “industrial production stalled in the second quarter and wage gains lack oomph, both of which move the recovery further into the distance.”
Moody’s concludes that the Ueda BOJ “is hiking into a weak economy. Indeed, there is a good chance that Wednesday’s decision will be remembered as one of the BOJ’s more controversial ones.”
The Fed faces myriad uncertainties of its own. Powell’s team confronts the specter of a Trump 2.0 White House, which seems primed for battle with the Fed over monetary independence.
During his first term from 2017 to 2021, Trump browbeat the Fed into cutting rates at a time when the US didn’t need fresh monetary stimulus. Trump even threatened to fire Powell.
If Trump wins another term on November 5, he might implement the “Project 2025” blueprint that includes eradicating the Fed system. Trump also is believed to favor devaluing the dollar.
Tokyo worries that weak Asian currencies – including the yen – might become a political talking point ahead of November. This fear is among the reasons Japan’s Ministry of Finance is working to prop up the yen. Tokyo spent more than $3 billion in the last month to put a floor under the yen.
The currency surged on Wednesday after Ueda’s minor rate hike, partly because he hinted at more tightening steps to come.
“Ueda’s hawkish comments and the content of the policy statement point to risk of the next hike to be brought forward earlier, depending on upcoming data. We see flattening of Japanese government bond curve as markets price in sharper rate hike cycle within short period,” says Takeshi Yamaguchi, economist at Morgan Stanley MUFG.
But it’s the PBOC’s Pan who faces the most challenging road to 2025. One reason is uncertainty about the timing of Xi’s plans to ramp up government stimulus.
“The Politburo is signaling a renewed emphasis on shoring up the domestic economy through consumer-focused policies, as China navigates economic headwinds,” says Carlos Casanova, economist at Union Bancaire Privée.
“However, investors were hoping to see actionable measures emerge from the July meeting. Instead, the announcements seemed to lack concrete details, leaving the impression of sizzle but no steak,” Casanova says.
Until there’s greater clarity, he says, “the 10-year government bond yield in China is likely to remain suppressed in the coming weeks, as the government rolls out additional policy support measures.”
All the global financial system can do is hope that Pan gets right the timing, magnitude and sequencing of rate cuts.
Nothing would cheer global investors more than the biggest trading nation beating this year’s 5% growth target in a big way and defeating deflationary pressures in short order.
That’s why this year’s most impactful monetary policy calls won’t be in Washington or Tokyo, but rather in Pan’s office.
Follow William Pesek on X at @WilliamPesek